Bob Champion

Retirement income freedom and choice

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4th February 2019
Bob Champion LLA Later Life Academy

Much is made of the impact of the Pension Freedoms reforms introduced in 2015. Since then, we have received regular statistics from FCA and HMRC providing details on how people have used their pension savings.

Each announcement tends to be accompanied by the usual commentary often implying people are still making the wrong decisions regarding their pension savings. This, in a very true sense, led to the FCA Retirement Outcomes Review.

In addition to large numbers cashing in their pensions, the Review identified a large number of non-advised consumers investing their pension drawdown accounts in cash. Recently this may not have been a bad decision if the objective was to invest once markets stabilised. The feeling however is that this is not their intention.

For the latter, the outcome of the review will result in more disclosure and investment pathways for non-advised pension drawdown clients.

The two largest components of wealth in retirement are pension and housing wealth. However, their history dictates how they are viewed differently by regulators and many commentators.

The Government gives tax reliefs to encourage people to build pension wealth for their retirement. There are various tax penalties (to claim back the tax relief) if more is saved than the Government allow, or the money is not used as the Government intended.

To me, many read too much into the impact of Pension Freedom and Choice as to how people are using their pension savings. When I first became involved with pensions in the early 1970s many of my firms’ clients provided generous defined benefit pension schemes for their salaried staff. Often ‘works’ employees either had to depend upon the State or make their own provision for retirement income. Those who were fortunate enough to belong to a works pension scheme may only have received a lump sum at retirement.

Under Occupational Schemes it was possible to take up to 3/80ths of final earnings (sometimes more) as a tax-free lump sum for each year of service, with the balance having to be used to provide a pension. Up to this limit the choice was a tax-free lump sum or a taxed income. There were no regulators at that time to collect data on what scheme members actually did, but I can have a good guess.

It was pension simplification in 2006 that restricted cash sums on retirement form occupational schemes to 25% of the accrued pension pot, unless protection resulting from rights that had built up before 2006 applied. We have lost sight that before 2006 many exercised their freedom and choice by using some or all of their tax-free pension lump sum to buy a purchase life annuity - the opposite of today. When pension savers cash in their old pensions they may be doing just what they expected to do whilst they accrued that pension.

The history of the use of housing wealth in retirement is completely different. The Government objective has been to encourage individuals to own their own home. No thought has been given to using their home for retirement income. When it comes to using their housing wealth to provide income in retirement, unlike pension wealth, the consumer has complete freedom and choice.

This may be surprising considering many have received government help to purchase their homes. Until 2000, house purchasers may have received mortgage interest tax relief; close to two million households have benefited from right to buy schemes; there is no tax on gains from home sales, and for some, additional relief from inheritance tax can be obtained. This ignores Help to Buy schemes.

Freedom and choice in the retirement income housing market takes many forms. The homeowner has many choices - they can:

• Downsize and use the capital realised to generate income;
• Take out an interest-only mortgage;
• Use equity release to provide capital to live off or buy a more expensive home.
• Move in with a friend or relative and live off the rental income generated from the home.

Thanks to the Equity Release Council we know that in 2018, 82,791 customers released money from their homes through equity release plans. We should not be surprised if this number exceeds 100,000 in 2019. To put this in context, in the year ending March 2018, FCA data shows 70,866 annuities were purchased and 188,544 income drawdown contracts were created.

FCA and HMRC data releases tell us what is happening with retirement income generated from pension savings. What we do not know is what the unadvised are doing with their housing wealth. How many are downsizing and putting money released on deposit with a bank or building society?

If they are intending to use that money over the long term for retirement income, are they doing anything different from someone who uses cash as the investment for their pension drawdown account? Is this not where the FCA Retirement Income Review came in? The Retirement Income market is more than just pensions.

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